Wednesday, June 27, 2012
May capital goods orders (a good proxy for business investment) were up a bit less than expected (1.6% vs. 1.9%), but the bigger story is that they haven't increased much at all over the past year. Business investment has gone flat for the past year. If anything explains why the economy has been sluggish, this is it. Corporate profits are very strong, but businesses are reluctant to put those profits to work.
It's not hard to understand why business investment has been flat. U.S. corporate tax rates are the highest of any developed country. Regulatory burdens have been increasing relentlessly. Obamacare threatens to push healthcare costs even higher, while adding to regulatory burdens, but until tomorrow we won't know if it is actually going to happen—that adds up to lots of uncertainty if nothing else. With the federal government spending 23% of national income, while collecting only 15.3% of national income in taxes, corporations and individuals are justified in fearing a significant increase in future tax burdens.
Another to look at it: in the four quarters ended last March, total after-tax profits of U.S. corporations were about $1.5 trillion, while the federal budget deficit was $1.25 trillion. The federal government effectively borrowed and spent 83% of all the profits earned by U.S. companies. Corporations worked hard to generate profits using scarce resources in the face of increasing difficulty, but the government effectively took most of those profits and redistributed them. The profits weren't invested, they were handed out in the form of unemployment benefits, food stamps, welfare, grants to green companies that failed, and grants to state and local governments so that they could avoid cutting back on their bloated spending, among other non-productive endeavors. Government "spending" of this sort doesn't create jobs, it simply wastes scarce resources and ends up weakening the economy.
With excessive government spending effectively smothering economic growth, those who are able to save end up "investing" their money in Treasury debt because the outlook for growth in the private sector is bleak and uncertainty is high. It's a vicious circle: the more government spends and borrows, the weaker the economy becomes; the weaker the economy, the more investors become risk-averse; and the more risk-averse investors become, the more they want to invest in Treasuries. Treasury yields are at rock-bottom, all-time lows—and TIPS real yields are negative—because the market holds out very little hope for any meaningful growth or any substantial improvement in the outlook.
This is the best explanation I know of for why the huge increase in federal government spending and borrowing has pushed interest rates down instead of up.
The way to break out of this vicious circle is to reduce the size and scope of government, increase the rewards to private-sector risk-taking, and reduce regulatory burdens. There is hope that this will happen; after all, federal spending has already declined from a high of 25.3% of GDP in Sep. '09 to 23.3% in Mar. '12, thanks to the fact that spending has grown by less than the growth in nominal GDP.
Posted by Scott Grannis at 9:01 AM